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China Stocks Offer Opportunities Amid New Challenges

Today is the start of a new era for China -- and for investors in China stocks. The 18th Chinese Communist Party Congress is getting underway to install new national leaders who will have to cope with slower economic growth. An end to breakneck economic expansion will challenge both leaders and investors, but one veteran fund manager sees both short and medium-term opportunities.

Change is unavoidable because the old economic model that grew the Chinese economy into the world’s second largest is faltering. Higher costs and weak overseas markets sap growth in the vital export sector. Massive fixed asset investments, another pillar of China’s economic miracle, now lead to inflation, corruption and oversupply.

New political leaders, headed by Xi Jinping, will have to deal not only with a lower economic growth rate but with the pressing social problems of corruption and income inequality caused by overheated growth. Investors will find that slower economic expansion gives the old China Story for stocks a new plot.

“There is less likely to be 9 or 10% growth,” said William Fong, investment director at Barings Asset Management. “Stock selection will be more important. It’s different from the last few years when no matter which sector or stock you picked you would probably experience very high growth.”

In addition, the overall market may look unappealing. The benchmark MCI China Index is heavily weighted toward banks and telecoms, according to Fong. Slow growth in these sectors may hold the index back: banks because of questionable asset quality and telecoms because of heated competition.

But that doesn’t mean an end to opportunities in Chinese stocks, said Fong, who is the investment manager of the Barings China Select Fund. In the short term, he said, economic growth will rebound early next year from the 7.4% rate in the third quarter this year. One reason is that expansion will be measured from a low base in 2012. Hong Kong stock indexes have already moved higher in anticipation of stronger growth.

In the longer term GDP will probably rise 7.0 to 7.5%, a modest rate by recent Chinese standards.

Fong doesn’t comment on individual stocks, but he sees good prospects for a number of sectors, even with a slower economy. Exports will regain some of their luster as the U.S. economy recovers, he said. Reforms expected from new leaders will open opportunities.

“Actually a lot of sectors will benefit from reforms if leaders do it right,” Fong said.

One of the most critical areas of reform is a move to more income equality. Stronger government pension, medical and housing plans are among measures that will help China’s rural masses. With a more reliable social safety net, hundreds of millions of rural residents will be more willing to spend more of their ample savings. Consumer staples producers and retailers stand to benefit. Needed financial reforms might boost insurers and brokers.

On the level of individual stocks, Fong said, “The bottom line for the next five years is to pick companies that can grow market share, offer higher value-added products and meet customer needs.” End

Chinese Stocks in the U.S.: -5.9, 386.0, 11-07-12, Bank of New York Mellon, ADR Index-China - closed by storm

Insight: Hong Kong plunged below its 20-day moving average in heavier turnover in line with steep losses in New York as fears of an impending U.S. fiscal crisis grew. Steep declines in international financial stocks dragged down HSBC (HBC), which fell 2.1%. KGI Research

Brokerages and analysts cited here have disclaimers on their websites emphasizing their statements are for information only. They do not endorse my blog, and I don’t endorse them.

For a list of Chinese companies sold in the U.S. and information on each company go to http://www.adrbnymellon.com/dr_country_profile.jsp?country=CN

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